Download Economic Conversion in Perspective

Economic Conversion in Perspective
MARSHALL GOLDMAN AND ETHAN B. KAPSTEIN
ith the end of the Cold War, the conversion of defense industries to
commercial production has again become a topic of interest for
public officials, business executives, and scholars around the
world. The prospect of massive layoffs in defense industries, coupled with
the release of hundreds of thousands of military personnel, creates a political
problem for officials from affected districts, while decreases in defense
spending, coupled with budget deficit reduction, could lead economies into
recession. In short, the defense economy has become a political problem for
many countries, most prominently the United States and former Soviet
Union.
In seeking remedies, editorialists and legislators have called for more
government action to help defense industries compete in the commercial
marketplace. The former chairman of the Joint Economic Committee,
Senator Paul Sarbanes, has suggested that government contracts for
commercial products and services could intentionally be let to defense firms
in order to provide the incentive structure needed for them to enter new
fields.1 President Bill Clinton has created a "technology reinvestment
program" airned at encouraging defense firms to produce "dual-use"
technology for both the military and commercial sectors. And the United
States government has also been assisting the Newly Independent States
(NIS) through its Cooperative Threat Reduction program as they attempt to
turn guns into butter.
Part of the rationale for this government activism is found in the
prevalent reading of the historical record. After World War 11, it is
commonly said, both the United States and Soviet Union engaged in
massive conversion programs. These programs allegedly helped the economy
transform from war- to peacetime, and made it possible for defense firms to
re-enter the civilian economy.2
In this piece, we offer a contrasting view oí' the conversion process. In
part one, we argue that the perceived version of history is largely a myth and
that it is inappropriate to focus policy attention on conversion at the plant
leve]. Instead, we suggest that conversion is best seen as a macroeconomic
process, in which the factors of production move to their most efficient uses
in response to the development of new economic sectors and industries. A
corollary is that in the absence of economic growth, conversion is likely to
become more politicized, with the possible ironic result that under such
conditions defense firms may be kept going by governments in Keynesian
fashion.
In part two, we turn to some historical examples of conversion from the
United States and Western Europe. This history, unlike that which has
W
Marshall Goldman is a professor at the Department of Economics at Wellesley
College, and at the Russian Research Center at Harvard University. Ethan B.
Kapstein is with the John M. Olin Institute at Harvard University. This article was
written as part of the Consensus Project at Harvard University.
55
56 DEMOKRATIZATSIYA
entered public memory, suggests that plant leve] conversion has generally
been a failure. That does not mean , however, that governments have no role
to play as defense expenditures decline. On the contrary, macroeconomic
policies that maintain aggregate demand, coupled with micro-policies that
help workers to retrain, are of great value as societies cope with downsizing.
In part three, we focus on the former Soviet Union. No country in
modern history built a larger peacetime defense industrial base than the
Soviet Union, and now Russia must face the challenge of making that
industrial base a useful contributor to a new political economy. We suggest
that policies and programs-including Western assistance programsfocusing on plant-level conversion are of only limited value, and that the
best hope for Russia is economie growth and the creation of new industries
that will allow the factors of production used in the defense sector to find
new outlets. Owing to relative factor immobility, such industrial policies
may be targeted at the regional level over the mediumterm, but over the
longrun the policy objective should be to encourage the reallocation of
resources on an economy-wide oasis.
We conclude the article with some policy implications and recommendations, which hopefully will be of value not just for American officials,
out for those in Russia and other countries as well.
I. Conversion in Theoretical Perspective
From a macroeconomic perspective, defense spending has constituted a
significant share of government expenditures in the United States since the
Second World War. Even in the
current economic and security
"While industrial conversion does enviromments, with deficits on the
one hand and the collapse of the
take place from time to time, it is
Soviet threat on the other, defense
likely to be statistically
consumes more than one-quarter
il2signiftcant.
of all government outlays. In short,
defense spending continues to
exercise a profound influence on the nation's pattern of resource allocation.
For particular regions, the role of defense looms especially large. During
the Reagan years, for example, New England was a major beneficiary of the
defense build-up. From fiscal year 1987 to 1989, residents of Massachusetts
received an average of over $1400 per resident, and those in Connecticut
over $1600 per resident, on the basis of local defense expenditures. These
figures were about three times the national average.3
Similarly, particular firms and industries are vulnerable to defense
cutbacks. The "prime contractors" (e.g., Lockheed and Raytheon), whose
defense sales as a percentage of overall sales are more than 75 percent,
immediately come to mind, but they are not alone. Indeed, supporting these
primes are thousands of equally dependent subcontractors. The termination
of defense contracts has a multiplier effect that reaches deep into firms and
their communities.
It is not surprising that defense cutbacks, in the absence of other forros
of government spending, will have a recessionary effect. According to
economist Alan Reynolds, "there has been a recession after every major war
in U.S. history. . . . Why should the Cold War be any different?" Reynolds
points out that during the four post-World War II periods of downsizing,
Economic Conversion in Perspective 57
unemployment rates rose from between 2.4 to 10.3 percentage points, and
industrial commodity prices generally fell sharply.4 To date, economic
growth has allowed the United States to avoid this fate, although there is
some evidence that former defense workers are finding new jobs at greatly
reduced wages.
In the wake of sharp declines in defense spending, public policy is faced
with two major problems: first, the loss of demand for military goods and
services; second, the matching of resources once employed by the military
with new civilian requirements. The macroeconomic task is thus to stimulate
demand, while micro-policies should be adopted to case the transfer of
resources to alternative employment. Far from simply relying on the "magic
of the marketplace," governments have an important role to play in the
conversion process.
Government policies aimed at maintaining economic growth and
investment have at their disposal five general instruments:
(1) tax policy, especially tax
cuts; (2) monetary policy,
specifically lower interest
rates; (3) increased govern ment purchases of nondefense
items; (4) increased transfer
payments and adjustment assistance to displaced workers
and industries; and (5) export
promotion policies. The suc-
"Exports were pushed overseas to
meet the world 's reconstruction
needs, and with the passage of the
Marshall Plan in 1948 these exports
were largelyfinanced by American
taxpayers.... Less successful,
however, were attempts to convert
guns into butter at the plant level."
cess of economic conversion
will largely be a function of these aggregate offset policies. The higher the
general demand in the econorny, the faster market forces will operate,
facilitating the shift of resources from defense to commercial sectors. From
an historical perspective, the U.S. government has employed all these policy
instruments at one time or another in the face of decreased defense
spending.5
In sum, a mix of macro- and microeconomic policies is required in order
to make a successful transition to lower levels of defense expenditure. But
the best way to think about conversion is as a macroeconomic phenomenon.
That is, what policymakers should worry most about is the reallocation of
the factors of production (capital and labor) to their most productive
alternative uses, rather than focusing on efforts to turn guns into butter at the
plant level. While industrial conversion does take place from time to time, it
is likely to be statistically insignificant. In the sections that follow, historical
lessons are drawn from earlier conversion in the United States and elsewhere
in support of this argument.
II. Conversion in Historical Perspective
During the Second World War, the United States virtually transformed itself
into a command econorny. Defense spending reached almost 40 percent of
gross domestic product in 1944 and made up 90 percent of the federal
budget. Over the two-year period 1945-47, the economy faced incredible
challenges as eleven million Americans left the armed services, an
58 DEMOKRATIZATSIYA
additional two million left civilian jobs working for the military, and
defense-related employment in industry fell by about ten million jobs.6
American policies for shifting to a postwair economy began to take
shape in 1943, when Franklin D. Roosevelt's top advisor, Jimmy Byrnes,
was asked to chair a conversion taskforce, while at the lame time the U.S.
Senate established a Special Committee on Postwar Economic Policy and
Planning. The programs subsequently fashioned were directed toward both
the macro- and microeconomies, though the latter had mixed results.
Most important from the macroperspective were the Keynesian
measures adopted after the war to maintain full employment, which had as
its noblest expression the Employment Act of 1947 and the lifting of price
controls that same year. Exports were pushed overseas to meet the world's
reconstruction needs, and with the passage of (he Marshall Plan in 1948
these exports were largely financed by American taxpayers. Domestic
demand was stimulated through such measures as the G.I. Bill, which made
it possible for ex-servicemen to
purchase new homes. And these
"What saved the American
servicemen found jobs with
econorny ater the war was the
amazing speed, often at the
pent- up demand and savings that expense of women and minorities
who hetd many manufacturing
enabled millions of consumers to
jobs during the war.
enter the marketplace for the
Less successful, however,
goods and services they had
were attempts to convert guns
longed for since the Depression ." into butter at the plant level. As
part of the Byrnes conversion
effort, teams of engineers were
dispatched to defense plants across the country, studying their potential for
commercial production. By 1949, these studies were in the dustbin, and this
part of the conversion program was deemed a failure. Former defense
enterprises were out business, their machine toolls dumped into the ocean.
The American economy indeed converted from a military to a commercial
basis, but many wartime defense firms failed in the process.
It is of current interest to note that the topic of economic conversion was
rife with controversy in World War II America. After all, the government
held title to a significant fraction of the nation's industrial base, including 90
percent of the synthetic rubber, aircraft, and magnesium industries and over
50 percent of the aluminum and machine tools industries. In short,
conversion was a process of some consequence for the American political
economy. As one historian of the process has remarked, "The ways these
plants were transferred from wartime to peacetime service held the potential
for economic social change."7
The experience of the Second World War points up the importance of
the macroeconomy in defense conversion. To be sure, government policies
that retrained servicemen or helped them find jobs were of great value, but
their corollary at the level of the firm generally failed. What saved the
American economy after the war was the pent-up demand and savings that
enabled millions of consumers to enter the marketplace for the goods and
services they had longed for since the Depression. Indeed, the first cars
produced by the automobile firms after World War II were not new modeis,
but 1939 products made with pre-war machine tools!
Economic Conversion in Perspective 59
The United States was still engaged in postwar conversion in 1950,
when the Korean War erupted and led to industrial remobilization. Thus, six
years after the process was launched, it was nowhere near completion. There
are important lessons to be drawn from this experience, chief among them
that even given macroeconomic policies that catalyzed postwar growth,
millions of workers-especially women and minorities-lost their jobs in
postwar America. The United States econorny recovered from war with
remarkably little recessionary effect, but nonetheless a painful period of
adjustment occurred.
Of even greater contemporary relevance, perhaps, is the post-Vietnam
experience. After the Vietnam conflict drew to a Glose, defense firms had a
difficult time in the postwar environment. On the macroeconomic level, the
American economy was performing badly in the 1970s, suf-
fering from a fatal mix of
stagnation and inllation-stagflation-that followed in the
wake of the Arab oil embargo.
Scrambling for niches in this
dismal environment, defense
companies entered new busi-
"... the government should not
give false hopes thatjobs and
plants can be maintained and
converted. The historical record
suggests that this simply does not
happen."
nesses , from building buses
(Grumman) to bathtubs (Boeing). For its part, General Dynamics went on to lose money in shipbuilding
and asbestos mining.8
Overall, the record of defense industries in commercial enterprise has
not been a good one. The record from both the post-Korea and post-Vietnam
periods suggests that defense firms divested themselves within five years of
the vast majority of non-defense business that they tried to enter.9
Advocates of defense industry diversification would do well to recall that a
booming commercial sector already exists in the United States, always
seeking new consumer products for a seemingly insatiable marketplace. In
such an environment, it is unlikely that defense firms will develop some
unique competitive advantage.
The French experience after the Algerian War lends further support to
the argument made here about the importance of macro-factors in economic
conversion. After the Algerian War, the French were faced with the
necessity of converting many of their naval shipyards to alternative uses.
From a technical perspective, it appeared that the shipyards in Britanny
would be easier to convert than those in the Mediterranean, but by the mid1960sthe French had discovered that conversion had been more successful
in the latter case. Upon investigation, it was found that this was due to the
locational advantages of the Mediterranean yards. Because the
Mediterranean economy was growing at this time, shipyards were able either
to convert to marinas or to become repair yards for yachtsmen, or the
workers were able to find new jobs in tourist-related industries. In Britanny,
by contrast, the regional economy was slumping and conversion efforts
failed. Efforts to convert shipyards ran into daunting human resource and
physical infrastructure problems, and the French state found it was making
much larger investments than planned in the effort. By the late 1960s, the
conversion program for Britanny was deemed a failure.10
60 DEMOKRATIZATSIYA
In short, neither the American nor the French experience gives much
hope for large-scale conversion of defense plants to commercial purposes at
the end of the Cold War. Instead, workers will find new johs as the world
economy begins to grow, and capital will flow to more productive uses than
making weapons. Over the long run, the process oí' conversion will benefit
both the global economy and global security. But in the short term, it will
bring tremendous pain to those who Nave given their lives to defense
industries. In order to help those workers move into new careers, the
government should provide retraining programs and perhaps grants to help
would-be entrepreneurs get started in small businesses. But the government
should not give falce hopes that jobs and planas can be maintained and
converted. The historical record suggests that this simply does not happen.
For the United States, which in recent years has spent at most 6.5
percent of GNP on defense, the story told here may be upsetting, but it is
hardly devastating. For Russia, in contrast, industrial conversion appears to
he a vital necessity. The industrial economy in Russia is largely inseparable
from its defense firms, and it would seem impossible simply to shut them
down and retrain the workers for new pursuits. In a country where the factors
of production are largely immobile-workers can't even move to new cities
for lack of housing-it would seem that defense conversion provides the only
way out of the economic doldrums. In the nexit section, we explore the
prospects for economic conversion in the former Soviet Union, with a focus
on the Russian Federation.
III. Military Conversion in the Former Soviet Union
That the United States has had such a difficult time with military conversion
must be very discouraging to those responsible for conversion in what once
was the Soviet Union. Not only must they deal with all the same obstacles
that hamper American efforts, but they must also contend with an array of
unique problems that by themselves would be enough to frustrate any policy
"... those officials in charge of
conversion never seem to be quite
sute how to implement the
conversion process. "
planner. At least in the United
States ihere is a reasonable sense
of order. Each state has not
seceded and declared its own
indeperidence. Nor is the United
States in the midst of an eco-
nomic collapse. It is hard enough
for the United States to deal with
recessions (drops in GNP of about 1 percent)-indeed, George Bush lost his
bid for reelection owing to domestic econornic problems-so we can
scarcely imagine the political difficulties of dealing with a drop in GNP of
20 percent or more.
If that were not enough, Russia is also undergoing a complete overhaul
of its economic institutions. Boris Yeltsin and his former chief economic
implementer, Yegor Gaidar, committed themselves to abandoning central
planning and replacing it with a market system. This has meant
implementing a program of privatization and market mechanisms such as
price flexibility, convertibility and even bankruptcy. In an effort to
accelerate this transformation and at the same tiene cure the depression and
the roaring inilation that ushered in this remolding effort, the government has
adopted a^policy appropriately described as shock. therapy.
Economic Conversion in Perspective 61
Any one of these measures would normally be enough to bring down
most governments. The Yeltsin government, for the time being at least, has
moved to adopt them all at once. At this writing, the Yeltsin government has
at least survived politically, albeit with strong challenges from the Duma
(Russian Parliament) and at the expense of most reformers who were in
positions of authority. What remains to be seen, however, is whether or not
its draconian policies can produce enough in the way of positive results to
keep the anti-reformists off-guard.
Against this backdrop, it is no wonder that the process of conversion in
Russia has not gone smoothly.
Those in charge are not even
cure how to proceed. At least «The first major effort at miliary
in the United States there are
conversion in the USSR had to wait
fully developed labor and capuntil 1960.... in 1964, when the
ital markets that can absorb
some of the factors of pro- opposition, led by Leonid Brezhnev,
duction that are spun out of conspired to oust Khrushchev, the
the military industrial sector. military supported Brezhnev."
Even then the United States'
market has difficulty finding a
productive use for most of those resources. How under those circumstances
can Russia expect a smooth transition when its market is at best shaky and
untested and the economy is shrinking, not growing? For that matter, those
officials in charge of conversion never seem to be quite sure how to
implement the conversion process. Intellectually, they know they should use
market forces to redirect the country's resources. Instinctively, however,
even Yeltsin's so-called market reformers have a tendency to fall back on
central planning procedures by decreeing one course of action or another. It
is an unenviable position.
IV. Historical Perspectives
Russian leaders have had little opportunity to prepare themselves for dealing
with their present circumstances. Not that our past failures have made
current efforts much easier this time around, but based on severa) past
attempts at conversion we at least have an idea of what to expect. Thus, we
have some experience to draw on. For the Russians, the situation today is
considerably different from what they had to face in earlier years.
Admittedly, they did have to cut back alter World War 1 and World War II,
but conditions then were not the same as now.
While Russia did conscript a large army in both World War 1 and World
War II, demobilization was not a major concern. After World War 1, the
process of reabsorbing veterans and converting industry more or less took
care of itself. Most of the soldiers simply went back to their villages. After
all, more than 80 percent of the Russian population at the time was rural."
There was no need for them to find jobs in the city.
The same situation held in industry. Russian industry was relatively
underdeveloped at the time. There was not much to reorient. Moreover, the
Civil War and the introduction of communism, which followed on the heels
of World War 1, resulted in the collapse of much of the civilian economy. Its
recovery began after 1921, and Lenin's introduction of the New Economic
62 DEMOKRATIZATSIYA
Policy was an attempt to promote rapid economic growth through
industrialization. This policy continued and accelerated under Stalin.
Indeed, industrial conversion was scarcely oí' concern. As noted earlier
in this article, conversion is less of a problem in an economic environment
that is marked by rapid economic growth. That certainly characterized the
1920s. Furthermore, heavy industry, the kind of industrial activity that serves
as the core of a military-industrial complex, is exactly what Stalin favored
in the industrial expansion effort. The five-year plans gave pride of place to
steel, machinery, heavy construction equipment, and, for that matter,
military production. If anything, Stalin wanted more, not less, from his
military-industrial sector.
The post-World War II conversion experience was much the same.
There was no special emphasis on the civilianization of the economy; Stalin
continued to stress military preparedness. To Stalin, the Soviet Union was
cncircled by a hostile capitalist world waiting to pounce. This was soon to
hecome the Cold War. Stalin kept the country on a war footing throughout
his lifetime, and that condition lasted into Nikita Khrushchev's era.
The Soviet Union also differed from the United States in the magnitude
of the conversion problem because,
unlike the United States', most of
"As it evolved, the Soviet system
carne to incorporate some
procedures that made
the Soviet industrial infrastructure
was destroyed in World War II. Not
surprisingly, the emphasis was on
economic reconstruction and
growth, not conversion. This, combined wii:h the military build-up,
meant that there was virtually no
need to close or reorient any factories. On the contrary, virtually every factory was put under enormous
pressure to expand its existing output in both the civilian and military
sectors. Occasionally there would he a change in the model of what was
being produced, but seldom was there any need to alter the output mix of a
particular factory. There is no better illustration of how important economic
growth is to ameliorating the difficulties of conversion.
Nor was manpower conversion much of a difficulty. That was due in part
to the great loss of life during World War II. If anything, there was a great
shortage of industrial labor after World War II. Moreover, just as after World
War 1, a large percentage of military personnel returned to their farms. There
had been considerable urbanization after 1917, but by the start of the war in
1940, 68 percent of the population continued to reside in rural areas.'` Again
the bulk of the veterans who survived the war simply returned to their
villages and picked up where they had left off.
The first major effort at military conversion in the USSR had to wait
until 1960. Then Khrushchev decided that it was time to reduce the Soviet
military establishment by 1.3 million men." Although the Soviet economy
was growing rapidly at the time, Khrushchev encountered enormous
resistance and ultimately had to pull back. Despite this about-face,
Khrushchev paid a high price for his efforts when the military, which had
once supported him, joined the opposition or at least failed to oppose it
when an effort was made to overthrow him. Thus in 1964, when the
opposition, led by Leonid Brezhnev, conspired to oust Khrushchev, the
military supported Brezhnev.
conversion even more difficult
than in the United States."
Economic Conversion in Perspective 63
The difference between 1960 and the post-World War II era suggests
why the current effort at reform will be even more difficult to implement.
First, Soviet industry in 1960 was largely rebuilt and the memory of
reconstruction was fading. Even more important, by 1960 military and
industrial officials had become accustomed to their places in Russian
society. They were no longer in the army only for emergency purposes. In
effect, the Soviet Union, as noted earlier, was on a war footing for most of
the post-World War II era, and that meant that those who had risen through
the ranks had become accustomed to many privileges which they carne to
view as considerably more than a temporary perquisite. Not surprisingly, the
military-industrial complex was
reluctant to surrender perks and
power and enter the regular
almost all military -industrial
civilian workforce. Civilian pay
enterprises in the Soviet Union
and prestige in no way matched
Produce consumer goods as well.
that of those engaged in military
activities. Nor was Khrushchev's
promise to divert resources to advanced research and development much of
a recompense (interestingly, Gorbachev would attempt the same ploy with
the military-industrial complex during the early days of perestroika). Existing
military forres wanted increased funding for their own activities, or at least
a continuance of the status quo. They viewed it as an entitlement-just as
their counterparts in the United States do today.
As it evolved, the Soviet economic system carne to incorporate some
procedures that made conversion even more difficult than in the United
States. The Soviet planning system was predicated on what carne to be
known as the "val" system. Factory managers were rewarded if they could
show that the ruble value of this year's output exceeded that of last year.
There were two ways to do that. One was to produce more goods. However,
given the way inputs were priced, a bonus could be won simply by producing
a more expensive bundle of the same or a smaller amount of goods. Products
were priced not according to the supply and demand pressures but on a costplus, fixed-market basis. Thus, by incorporating more expensive and more
numerous inputs in the production process-no matter how wasteful that
might be-managers got their bonuses. As with American manufacturera
producing for the military, there has been a tendency in the Soviet militaryindustrial complex to foster the production of $600 screwdrivers.
In fact, there are reports that a labor hour in the Soviet military costs
five to six times what it would cost in the Soviet civilian sector.14 That also
means that there is little concern about miniaturization. There is no reward
for it. No wonder Soviet officials were said to pride themselves on their
ability to produce the world's greatest microchip! Having mastered such
techniques, it is understandable why so many enterprise managers in the
military-industrial complex are reluctant to throw themselves finto a more
competitive environment.
Their disdain for civilian production is in part a product of firsthand
experience. It turns out that almost al] military-industrial enterprises in the
Soviet Union produce consumer goods as well. In 1989, for example, it was
reported that 40 percent of the output of the military-industrial complex was
already categorized as civilian. For example, 95 percent of all the
country's refrigerators were manufactured by predominantly military, not
64 DEMOKRATIZATSIYA
civilian, factories. Over 60 percent of the country's washing machines and
vacuum cleaners were produced in the same fashion.'6 Having observed
such operations firsthand, managers at military factories know better than
anyone else that their civilian counterparts have always been treated as
second-class citizens, not only as to pay but also in tercos of both prestige
and access to quality raw materials and equipment . Moreover, they also see
how uncompetitive such consumer goods are. Given the "val" system, it is
not surprising that without exception Soviet consumer goods are bulkier and
of poorer quality than those produced in the West. No wonder there is not
much eagerness to shift out of the military sector.
On the other hand, conversion has become a necessity for these very
managers and their plants. The simple fact is that military orders have fallen
to a small fraction of Cold War levels, while demand for consumer goods
continues to rise. It is for this reason that Deputy Minister of Economy
Sergey Vasilyev proclaimed that "conversion is complete." 17 While that
statement is , of course, optimistic in the extreme, it does point to the
changing nature of the post-Soviet economy and its consequences for
defense producers.
V. The Yeltsin Reforms
Having committed themselves to the process oí' conversion, what are the
prospects for Yeltsin and his reform team? Just as in the United States, the
prospects for the defense sector as a whole are dinn. Not only is there still no
market system available to absorb at
least some of the newly released
capital and labor resources, but the
"American corporations have
absence of infrastructure (like
been having difficulty earning
housing) and the fact that most social
dollarprofits, or even
assets (housing, day care, medical
determining who their actual
facilities ) remain tied to specific
partner is."
plants limits factor mobility. Nor, of
course, does it help that the economic
system is in a free-fall depression
with GNP down by as much as 20 percent in one year.
As if this were not enough, the process of moving to the market and
privatization oí' industrial concerns is badly flawed. Because of ideological
hangovers froni the days of communism, there is still a considerable
resistance to privatizing ownership of land, although substantial progress has
been made with respect to privatization of factories and service facilities.
Still, in the absence of legal reform and the establishment of clearly defined
property rights, entrepreneurship, and foreign investment will remain
hampered.
It turns out, too, that many of those involved in the privatization effort,
and in private enterprise more generally, are unsavory types. Of course, there
are important exceptions, but criminals-or what the Russians refer to as the
mafia class-have become a major factor in the prívate sector. Combatting
crime is one of the major challenges confronting the emerging Russian state.
Alongside the private mafia, there are more mainstream privatizers who
are attempting to take control of manufacturing assets. For the most part,
these are one-time party, government, or managerial officials who have
come to assume a proprietary interest in the enterprises under their
Economic Conversion in Perspective 65
jurisdiction. It is a forro of primitive accumulation. Through one strategy or
another, they manage to transfer title or at least operational control over the
assets under their supervision. Occasionally such power grabs are openly
challenged, but in all cases there is uncertainty over the legal niceties of
such actions. As a measure of popular reaction to such efforts, the Russian
public refers to those involved as the "party mafia." It would not be
surprising if at some point there is a public reaction to such power grabs.
The Yeltsin government is attempting to control the whole privatization
process and open it up to legitimate competitors.18 There were open
auctions in several regions in 1992, and now regional privatization centers
are being opened to assist new management teams in the restructuring
process.1 Initially, most of this effort focused on the privatization of retail
shops, but more recently it has been extended to include the sale of shares
transferring ownership of factories (including many defense plants) to the
public as well as to the factory workers and managers of the specific plants
undergoing privatization. The workers and managers of these plants have, in
most cases, been offered discounts.20
Many defense enterprises have also sought to affiliate with foreign
manufacturers, a process that is now being facilitated by Western aid
programs. Sometimes this has produced rather unorthodox alliances. Polaroid
recently teamed up with the Ministry of Atomic Energy, including some
divisions respon-sible for producing nuclear weapons. Gillette allied itself
with a branch of Leninetz, one of St. Petersburg's biggest military
producers.21 Razor blades would hardly be considered high tech-nology, but
for the Russian partner it did offer a chance to earn hard currency, and that
was as important as any other consideration.
Branching into either Polaroid cameras or razor blades is probably one
of the best examples of the conversion process at work. Unfortunately, from
the Western partner's viewpoint, the transformation is not working as well as
anticipated. Because of the collapse of the value of the ruble and the chaos
involved in establishing government jurisdiction, American corporations
have been having difficulty earning dollar profits, or even determining who
their actual partner is. Many of the same factors explain why the
Batterymarch Financial Management Fund of Boston has abandoned its
quest (at least temporarily) to invest in some of the more sophisticated
military technology developed in St. Petersburg. Even for those with a long
time horizon, the business climate has become too uncertain.
Questions about the viability of massive conversion, and the
consequences of sharp cuts in the defense budget for regional employment,
have seemingly led Russian officials to rethink their programs in this area.
After some initial talk about an 85 percent cut in the military budget, calmer
heads began to realize what Che economic and political implications of such
a drastic step would be.22 These bold efforts were then replaced with more
moderate efforts to set military expenditures at about 5 percent of the GNP.23
It was also decided to allocate budget funds to military producers who would
otherwise be forced to close or go bankrupt. The authorities concluded that
they could not risk the unemployment that such bankruptcies would bring,
especially in Siberia, where many cities are devoted almost entirely to
military production. For that matter, the situation is not much better in St.
66 DEMOKRATIZATSIYA
Petersburg, where reportedly 70 percent of the city's industry is devoted to
military production.
The overemphasis on military production, with no evident need for such
equipment within the country, is why there are so many worries about
reported sales of equipment to outlaw countries such as Iran and Iraq.24
There are also fears that Russian weaponry vvill fali finto the hands of
terrorists. Already there are reports of nuclear reactors, not to mention
conventional weaponry, being offered for sale in the new commodity
markets that have mushroomed across the country. Because these needs
are so urgent and because they seem to have so few options, Russian
military factory managers are Hable to do anything to earn rnoney,
especially those who have been opposed to the ¡idea of conversion from the
beginning. Why should they cut back and refrain from production and sales
efforts to foreign clients, they ask, when they do not see Americans doing
the same thing? It is unlikely, however, that Russia will again become a
major arms exporter anytime soon, given the country's inability to assure
maintenance and spare parts to potential buyers.
Almost as troubling are reports of those officials who are literally
walking away from their problems. Numerous reports are appearing of
nuclear weapons and even submarine reactors simply being dumped, some
into the Bering Sea. There are at least seventy-two unloaded reactors from
submarines stored within Russia.26 Similar complaints (although not about
nuclear reactors) have been issued throughout Eastern Europe about
abandoned Soviet military bases. 27
Amidst all this gloom there are a few positive developments. Some
factories have moved from theory to practico and are producing new
consumer goods. Often they are rather simple in makeup, including such
elementary and unsophisticated products as household pressure cookers and
children's sleds. Some factories are moving into the manufacture of consumer electronics. Some working
groups (collectives as the
Russians vals them) have joined
"... our analysis suggests that
together to form new private or
while [U. S. conversion aid] may
cooperative enterprises, often
assist particular plants, it is
using i.echnology developed in the
hardly a remedy, and indeed it
course of their previous work for
could backfire as Westerners are
accused of 'cherry -picking.
the state . In severas cases, these
venturos have become quite
profitable.
When all else fails, some
enterprises have entered the salvage business. They have discovered, that if
nothing else, much of the existing military equipment can be sold for scrap
to Western buyers for dollars.28 Granted, the prives are a fraction of what it
would cost to reproduce some of what they are selling; but who needs
battleships today? Indeed, one of the reasons for the quarrel over the
ownership of the Black Sea naval fleet is that the ships are viewed as a
source of junk and hard currency. Because of the unusually skewed nature of
the ruble-dollar exchange rate, dollars go a long way in what used to be the
Soviet Union and almost anything portable is available for sale.
Beginning in 1994, it is likely that many more dollars will be made
available to assist the conversion process. As part of its Cooperative Threat
Economic Conversion in Perspective 67
Reduction program to dismantle weapons of mass destruction, the United
States government will be channeling millions of dollars into the militaryindustrial complex. A Defense Enterprise Fund is being created that will
make equity investments and take loans in defense plants that are
undergoing conversion. However, our analysis suggests that while this may
assist particular plants, it is hardly a remedy, and indeed it could backfire as
Westerners are accused of "cherry-picking." We would argue that Western
donors should focus their assistance at the regional leve], helping defensedependent regions facilitate the process by which workers and investment
capital can find their most productive uses.
Conclusions
The prospects for a successful conversion program in the defense industries
of the Newly Independent States are not very encouraging. Conversion will
be a hard enough process for the United States, even with the country out of
recession and rapidly growing; indeed, there is little evidence that defense
firms are diversifying into civilian pursuits, even with government financial
assistance as an incentive. When there is low or no economic growth,
however, not to mention the structural upheaval of the political and
economic system, such as we find in contemporary Russia, the chances of
success are very limited. Moreover, there is almost no wartime destruction
to repair or rebuild, which ironically
makes conversion even more difficult to
achieve.
"The prospects for a
It is not a particularly pleasant successful conversion
situation to contemplate. Only if shock
program in the defense
therapy works, sparking so much growth
from the civilian sector that it also industries of the Newly
stimulates an envious military-industrial Independent States are not
complex to join in, would there be much very eneouraging."
reason for hope. But the chances of that
happening, particularly in the near future,
are not high. To conclude, conversion is best seen as a macroeconomic
phenomenon, and Russian economic policy and Western assistance should
focus aboye al] on stabilization policies and legal reform. Policies are also
needed at the micro-level, including worker retraining and technical
assistance to start-up companies. Programs directed at existing defense
plants may be economically useful in some cases, and politically necessary
in others, but if conditions are not created to encourage foreign investment
and entrepreneurship, then Russian economic reform efforts will fail.
Notes
1. Paul Sarbanes, "Remarks in the Joint Economic Committee Hearing on
Defense Conversion," 9 April 1992, Washington, D.C.
2. On the U.S. case, see U.S. Congress, Joint Economic Committee, 1992 Annual
Repon (Washington, D.C., GPO: 1992); on the Soviet case, see Yevgeny Kuzentsov,
"Defense Industry Downsizing in Short-run Crisis Management," mimeograph,
Cornell University, March 1992.
3 . Yolanda Henderson, "Defense Cutbacks and the New England Economy,"
New England Economic Review (July/August 1990), 6.
68 DEMOKRATIZATSIYA
4. Alan Reynolds, "The Sky is Not Falling," Forbes, 30 March 1992, 152.
5. Roger Bolton, "Defense Spending: Burden or Prop?," in Bolton, ed., Defense
and Disannament (Englewood Cliffs, N.J.: Prentice-Hal f, 1966), 1-54.
6. Joint Economic Committee, Annual Report, 120
7. Gerald White, Billions for Defense (University, Ala.: University of Alabama
Press, 1980).
8. "The Pentagon's Menagerie," The Economist, 16 June 1990, 69.
9. Ethan B. Kapstein, "Testimony before the Joint Economic Committee," 9
April 1992.
10. Jean Chardonnet, L'Economie Francaise (Paris: Dalloz, 1970).
11. Gosudarsrnennvi Komitet SSSR po Statistiki, Narodrtoe khozaistvo SSR za 70,
(Moscow: Finansy i Statistika, 1987) 373.
12. ]bid. [The same page as the preceding note.]
13. Arkady Shevchenko, Breaking with Moscow (New York: Alfred Knopf,
1985), 92-93.
14. Sovset, 13 June 1991, 21.
15. Neti, Outlook, Summer 1991, 26; Foreign Broadcast Infortrtation Service
(FBIS), 25 July 1989.
16. Boston Globe, July 33, 1990, p. A-2.
17. Seminar at Harvard Russian Research Center, 18 April 1994.
18. New York Times, February 29, 1992, p. 5.
19. Boston Globe, 5 April 1992, 1.
20. For an excellent overview of the privatization process, see Maxim Boycko,
Andrei Shleifer, and Robert Vishny, "Privatizing Russia," Brookings Papers cn
Economic Activity 2 (1993): 139-192.
21. New York Times, 23 December 1991, D- 1.
22. ]bid.
23. FBIS, 27 April 1992, 31, 37; Moscow News, 7, 1992, 1; Moscow News, 39,
1991, 7.
24. Nezavisimapa Gazeta, 25 April 1992, 1.
25. Cornmersant, 16 September 1991, 6.
26. FBIS, 27 April 1992, 37.
27. Moscow News, 22, 1990, 3.
28. Conunersant, 6 April 1992, 14.